Friday, July 25, 2008

Finding Value in the Aerospace and Defense Sector

Stocks are getting pummeled left right and center in this market and the aerospace and defense sector is no exception. Table 1 shows significant downside movement from the 52 weeks highs for a few ETFs and market index in this specialized sector.

Table1: % Price drop from the 52 week highs in the Aerospace and Defense sector:My question is, how do we find value with individual stocks in this sector? In my opinion, a cheap stock equates to one that is trading at a price below its intrinsic value. One way to find those companies is to start looking for stocks that have been oversold, are currently out of favor with the market or are just generally being overlooked. Essentially, we want to look at stocks that are not behaving price efficient and as discussed here, its reasonable to start looking at small cap stocks. Table 2 shows what has happened to some of the small cap companies in the aerospace and defense sector.

Table 2: % Price drop from the 52 week highs for some small cap Aerospace and Defense stocks:

Looking over the sample of selected small cap stocks, we observe some extremely sharp price drops from the 52 week highs and this might be an indication of value. However, a relatively low price alone doesn't equate to value. The value comes from a low stock price relative its intrinsic value. One way to find potential value is to look at value indicators, such as price to earnings or price to book values. I have calculated the price to book values for our small cap aerospace and defense companies in the table 3.

Table 3: Price to book for small cap Aerospace and Defense stocks

We see from table 3 that the company with the largest price drop from its 52wk high (VSPC) is not trading at the lowest price to book value, indicating that price movement alone is not always indicative of value. We also observe 4 companies in the aerospace and defense sector (highlighted in green) that are trading at prices below their current book values! These companies are probably a great place to look for bargain prices by doing intrinsic value calculations and comparing them to the market prices.